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When banks fail: Maximizing FDIC insurance coverage

By Gina Pogol | Money Rates Columnist

Over the last few decades, bank depositors have been relatively complacent regarding the safety of their money, and justifiably so. Since its inception in 1934, the FDIC has never failed to cover an insured deposit. But in 15 bank failures prior to 1999, more than $114 million dollars in deposits were uninsured. To avoid that predicament in today's climate of big bank failure, investors need answers.

Which accounts are covered?

The FDIC insures checking, savings, money market (also called NOW) account, and certificates of deposit (CDs). It also covers cashier's checks, money orders, traveler's checks, accrued interest and other liabilities. As long as the institution holding these deposits is FDIC-insured, so are the deposits. In addition, many brokerages offer FDIC-insured CDs to their customers.

How much is covered?

The current FDIC limit is $250,000 per depositor, per bank. So if, for example, a depositor has a $210,000 CD that has accrued $6,000 in interest, $5,000 in a checking account, and $45,000 in savings, all at the same bank, the total of $266,000 isn't insured. Only $250,000 is fully covered if that bank goes under. The other $16,000 is vulnerable.

Does adding owners to an account increase coverage?

Coverage is allocated by account holder. So if an individual has a $500,000 savings account, only the first $250,000 is covered. But if the account is put in the names of two spouses, each gets $250,000 of coverage, so the entire account balance could then be insured (assuming that neither spouse has other deposits at the same bank). A cautionary note: Both spouses must have full and equal access to the funds (even in community property states) or the FDIC will consider only one of them an owner. The coverage then drops to $250,000.

Does opening different accounts at the same institution increase FDIC coverage?

Coverage can be increased by opening accounts with different ownership classification. IRA accounts -- self-directed or traditional -- are insured to a maximum of $250,000, and that is in addition to the $250,000 on other savings. Corporate (but not sole proprietorship) accounts are treated as separate from personal accounts and subject to their own $250,000 limits. Trust accounts may qualify for up to $250,000 in coverage per beneficiary if certain conditions are met. And depositors' shares in joint accounts are protected for up to $250,000 at each institution. So a married couple could keep $1,000,000 liquid and insured by dividing up the money as follows: husband's single account: $250,000, wife's single account: $250,000, joint account: $500,000 ($250,000 each).

Does distributing accounts among different banks increase coverage?

Because maximums are determined on a per account holder, per bank basis, distributing accounts among different banks can allow depositors to obtain FDIC coverage for 100% of their deposits. This is different from opening accounts at different branches of the same bank (which doesn't increase FDIC coverage). Borrowers who have accounts at two merging banks get a six-month grace period in which to move their accounts if the total balances exceed coverage limits.

Are there other ways to gain additional insurance coverage?

There are. The Certificate Deposit Account Registry Service (CDARS) allows depositors at banks registered with the network to buy FDIC-insured CDs up to a total of $50 million. This is possible because the network takes care of spreading the funds throughout different banks. The only drawback is that the rate offered may be lower than what could be obtained by shopping for rates with competing institutions.

What about other types of deposit insurance?

Credit unions offer their own version of FDIC coverage through NCUA. In addition, private deposit insurers offer supplemental coverage for amounts exceeding FDIC or NCUA limits, and some individual institutions choose to provide additional private coverage at no charge to their depositors.

How does the FDIC pay depositors when a bank fails?

If the FDIC is able to get another institution to take over, all accounts are merely transferred to the new bank. For example, customers of Washington Mutual were not affected by its failure because their accounts were immediately transferred to J.P. Morgan. Access to funds was unimpeded. If no banks can be found to take over, the FDIC cuts checks directly to the account holders -- usually in a matter of days.

What coverage mistakes do investors most commonly make?

In 1999, a customer found that of his $1.4 million deposited, nearly one million dollars were uninsured when his bank went under. How do these things happen? The FDIC claims that these most common errors result in unintentionally uninsured funds:

Joint accounts can go underinsured if one account holder is unaware of accounts held by the other at the same bank -- for example, if a couple has $500,000 in jointly held funds at their bank, but one spouse has another $100,000 stashed in a joint account with someone else, such as a child from a previous marriage. The total of $300,000 for that spouse exceeds the limit of coverage for joint accounts.

Deposits by real estate agents, attorneys or brokerage firms are made all the time on their clients' behalf. Funds can be put into escrow for real estate transactions, used to purchase CDs as part of an investment strategy or paid as an inheritance or settlement. If those deposits go into an institution where the recipient already has accounts, balances could exceed insured limits and the owner of the accounts left underinsured.

Brokerage accounts can cause other problems as well. If a broker pools an investor's funds with others but the account is not properly titled, it will only be insured up to the $250,000 limit regardless of how many actual investors own the money. The FDIC suggests that investors know what institutions their agents or representatives are using and keep track of all account balances.

A little diligence is all it takes to keep accounts insured, and the FDIC is very forthcoming about the methods that can be used by depositors to maximize their coverage. In fact, there's even an online tool for telling depositors exactly what's insured and what isn't. Investors simply enter their deposit information into the Electronic Deposit Insurance Estimator, or EDIE, and it calculates the amounts that are insured. The bottom line is that depositors are responsible for knowing pertinent laws, setting up accounts accordingly and protecting themselves.

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